The Internal Revenue Code provides the ability to take business deductions for meals and entertainment. You can take out a client to a restaurant or to a baseball game and deduct a portion of the expense.
The Internal Revenue Code, however, also requires you to jump through hoops to qualify the expense as deductible and is subject to limitations.
- Ordinary and necessary business expenses. All business expenses must meet the general requirement of being “ordinary and necessary” in carrying on the business. Generally, this boils down to whether it is reasonable for the business to entertain clients.
- “Directly related” or “associated with.” Next, a second stage of tests must be satisfied. Under these, the business meal or entertainment must be either “directly related to” or “associated with” the business. “Directly related” means involving an “active” discussion aimed at getting “immediate” revenue. Thus, a specific, concrete business benefit is expected to be derived, not just general goodwill from making a client or associate view you favorably. The principal purpose for the event must be business. If the “directly related” test cannot be met, the expense may qualify as “associated with” the active conduct of business if the meal or entertainment event precedes or follows a substantial and bona fide business discussion. This test is what you can use to if the purpose is to get new business or encourage the continuation of a business relationship.
- Substantiation. Estimates will likely not stand up to challenge. You really need to be able to establish the amount spent, the time and place, the business purpose, and the business relationship of the individuals involved. No one lies doing this, but keeping organized and detailed records saves you money in the end.
- Deduction limitations. Be careful, expenses that are “lavish or extravagant” are not deductible. But what is lavish and extravagant is based on the facts and circumstances. Most importantly, however, once the expenditure qualifies, it is only 50% deductible.